Buffett's Squanderville all maxed out

WARREN Buffett is the billionaire from a Norman Rockwell
painting who got rich by building a financial counter-culture
within his investment company Berkshire Hathaway, in which managers
loved their businesses so much they treated them like their
own.

But he's a worried man. Populist Republican presidents such as
Ronald Reagan and George W. Bush cut taxes without the hard work of
cutting expenditure. The resulting government deficits  along
with falling saving by households  have seen America go from
trade surpluses to large trade deficits far into the future.

And who's funding America's profligacy? The Asian countries
 particularly China  whose citizens, being huge savers,
have the funds to invest in America and the interest in continually
lifting America's credit-card limit so it can buy Asian goods.

But credit-card limits can't rise faster than income forever,
and as Buffett reminds us, quoting Herb Stein: "If something cannot
go on forever, it will stop."

Under current arrangements, that adjustment would happen via a
drying up of Asian finance, a depreciating American dollar and a
resulting recession  restraining America's rampant
consumption and shifting the competitive balance towards American
industry.

Buffett's concern with this solution is reminiscent of John
Keynes. Keynes thought competitive markets were admirably flexible
and efficient. But he also believed that certain "macro-markets"
 he was thinking of labour markets, but one could make
similar arguments about asset and currency markets  could
flout economic fundamentals for a long time.

Buffett makes his point with an economic model dressed as
storytelling. He invites his audience on "a wildly fanciful trip to
two isolated, side-by-side islands of equal size, Squanderville and
Thriftville".

Squandervillians live it up by borrowing from Thriftville 
something they can keep doing until they've mortgaged all their
assets, including their land.

This process could go on a long time before the market forces an
adjustment. And by then, what damage might have been done to
Squanderville's economic future, not to mention its strategic
position with its financier Thriftville (sorry, I nearly said
"China")?

Buffett proposes a remedy so simple it's odd that, given his
profile, it's received so little attention. Under his system, you
couldn't import into America without holding permits to do so. And
the only way to get a million dollars worth of import permits would
be to achieve exports of a million dollars from America  or
buy the permits from someone who had.

The system balances trade. And because it uses freely
exchangeable permits to do so, it's an extremely efficient way to
balance trade.

But why would you want to balance trade? Just as a company can
borrow to build a factory, nations can run trade deficits to build
their productive capacity. Buffett's concern is that America is not
investing its increased borrowing, that it's just living it up on
the credit card.

Even so, it's still not clear that what he's suggesting offers
any big improvements on the way the adjustment would otherwise
occur. I suspect he fears that Americans don't have the "ticker" to
choose to reduce their consumption to balance trade. But if that's
the case, they're unlikely to stick to his solution either.

Under his system, as with a declining US dollar, imports would
become more expensive, reducing consumption and funding increased
exports.

Intriguingly, having been introduced in Asia in the 1960s and
1970s, these ideas were further developed in Australia in the
1980s, though they were applied to a specific industry (rather than
the whole economy) in the context of reducing protection. "Export
facilitation" provided automotive exporters with permits to import
duty free into an otherwise outrageously protected market. That
helped move automotive production from local assembly of Ford
Lasers (when Japan could do it much more efficiently) to exporting
Holdens and Toyotas, which required much lower assistance.

At the same time, an Australian association, the Society for
Balanced Trade, was actively promoting the very idea Buffett is now
promoting. But, sad to say, its motives were simple protectionism
 the usual mix of special pleading for manufactures and
wilful ignorance of basic economics.

I doubt Buffett's idea makes sense for us now.

First, these mechanisms create explicit export subsidies that
are illegal under the World Trade Organisation. And whereas the
Americans might be able to secure a change in WTO rules, we'd have
no chance of achieving this on our own.

Second, though I think our trade deficit is too high, much of
its recent rise has been driven by surging investment. If we tried
to balance our trade, investment would almost certainly suffer. If
we have a problem, which I think we do, it's ultimately driven by
inadequate savings. So we should tackle that more directly 
with surplus budgets, Future Funds and/or expanded super
contributions.

Still, three big things can be said for Buffett's reinvention of
this Australian idea.

First, it avoids "picking winners", either between industries or
between import substitution and exports. That makes it more
efficient and dynamic, but minimises political favouritism and the
attendant rent-seeking.

Second, in a mercantile world full of countries making
successful development journeys using lavish export subsidies,
Buffett's system would get them thinking about importing more
 to secure their export access to the American market!

Third, whether or not there's a role for such policies in
developed countries, they offer a vastly superior mechanism for
responding to balance of payments crises than is now provided for
within current WTO rules, which permit the application of
"temporary", selective tariffs.

Sadly, Buffett's intervention has sparked almost no serious
interest from economists. I wonder why? Maybe economists can't
figure out where to place it on that spectrum between free trade
and protection that helps them work out where they stand. Is it
protectionist? Kind of. But implemented cleanly it would also
produce freer trade than any country has.

Back in the 1970s and 1980s, economists spilled oceans of ink
exploring the costs of new forms of protection though it was pretty
clear from the outset that they should be avoided where
possible.

They spent far less time exploring much more important new
mechanisms that were increasingly important in Asia's trade
liberalisation and development.

Partly because of that, Australian economists took too long to
understand (and revise their previous hostility towards) export
facilitation in the car industry despite its potential benefits.
And so it has been so far today.